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August 20, 2001
"How do we get rid of predatory
lending?"
Community
Action
There
are 4 general approaches to getting rid of predatory lending.
The first is to identify predators and either persuade them to change
their practices or counsel consumers to avoid them.
This is an approach taken by community groups such as ACORN, which is the
largest such organization in the US. But
this approach works only with large lenders.
Smaller predators are too numerous to attack in this way.
Restrictive
Laws and Regulations
A
second approach is to enact laws or regulations that restrict the practices used
by predators. Legislation
to curb predatory lending has been passed recently in North Carolina,
Mississippi and Minnesota, and proposed in New York and Illinois. These are bad
laws that will hurt the people they are designed to help.
The new legislation prohibits
contractual provisions that disadvantage the borrower, such as balloon payments
or prepayment penalties. The objective is to prevent mortgage brokers from
sneaking such provisions into the loan contract without providing anything of
value in exchange.
However, by making these
provisions illegal, informed borrowers can no longer trade them for something
they want, say a prepayment penalty in exchange for a lower rate. Taking away
such options from all consumers because some consumers don't read their
contracts is bad public policy.
A second common feature of the
new laws is a limit on the number of points mortgage brokers can charge. (One
point is 1 percent of the loan amount.) The objective is to prevent
price-gouging. In Mississippi, for example, the limit currently is 6 points but
it will become 3 points on July 1.
A 3-point limit means that
mortgage brokers cannot charge more than $600 on a $20,000 loan, or more than
$6,000 on a $200,000 loan. Since a broker doesn't spend any more time on a large
than on a small loan, this type of control is absurd. As mortgage brokers turn
away customers it is no longer profitable to serve, look for illegal
loan-sharking to prosper.
Why do legislatures pass these
laws? The mortgage brokerage industry has always had a sleazy element that looks
to extract every dollar from every customer in every possible way. In recent
years, however, the horror stories involving sleaze artists have risen both in
number and outrageousness.
Ironically, this is all the
result of the mortgage industry successfully expanding service to previously
under-served segments of the population. The emergence of this so-called
"sub-prime" market has meant that people with lower-incomes, little or
no cash, or shaky credit can now qualify for mortgages. This new group of
borrowers is often less educated and more vulnerable to predatory lending
practices.
The impetus for restrictive
state laws has come from community groups, who believe they protect consumers.
Their lobbying has been effective because the only opposition is mortgage
brokers who have little credibility and no alternatives to offer. Legislators
accept controls because they see no other way to deal with the flagrant abuses.
Promote
Trustworthy Loan Providers
A
third approach is to identify and publicize trustworthy loan sources to which
borrowers can be referred. This is
the approach I have taken in developing Upfront Mortgage Brokers (UMBs).
The limitation is that only a handful of UMBs exist at present, and the
public needs to be made more aware of how to use them.
Far preferable to price
controls and other such restrictions would be requirements that mortgage brokers
operate the same way other businesses must in a market economy. Brokers should
be forced to quote the price for their service before the service is performed.
The reason the market for
mortgage brokerage does not work effectively is that the price charged for
services is at least partially concealed until the transaction is completed. All
mortgage brokers do this, not just the sleaze artists.
Consider this: Borrowers pay
mortgage brokers on average $1,500 to $2,000 -- about what it costs to paint a
modest sized house. Consumers wouldn't dream of hiring a house painter without
knowing the price in advance and in writing.
But consumers retaining
mortgage brokers accept the industry's unwritten rule that what the mortgage
broker makes is none of their business! The consumer usually doesn't find out
the price until after the service is completed, and sometimes not even then!
There is no good reason why a
mortgage broker should not quote a price up front and in writing, the way a
painter would. That price should include all revenues obtained by the broker in
connection with the transaction, regardless of the source. This simple rule
would make the market work the way it is supposed to, and it would make price
controls and other restrictions unnecessary.
Consumer Education
The fourth approach to eliminating
predatory lending is to educate consumers on how to avoid becoming victims,
If there were no victims, there would be no predators.
That approach is discussed in How
Do You Avoid Predators?
Copyright Jack Guttentag 2002
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